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United States Cellular Corp. (USM - Analyst Report), a subsidiary of Telephone and Data Systems Inc. (TDS - Analyst Report) has reported second quarter 2011 earnings per share of 87 cents, superseding the Zacks Consensus Estimate of 40 cents.

The company’s earnings registered a whopping 87% growth from 47 cents in the year-ago period, driven by increased smartphone sales that led to high data and roaming revenues along with lower churn rates.

Net income attributable to shareholders increased 81% year over year to $73.9 million in the reported quarter.

Second quarter revenues of $1,076.1 million surpassed the Zacks Consensus Estimate of $1,063.0 million and increased 4% from $1,029.9 million in the year-ago quarter driven by strong smartphone sales.

Revenue, ARPU & Churn

Service revenue upped 3% year over year to $1,002.0 million. Revenues from Equipment sales were up 29% year over year at $74.2 million aided by a surge in smartphone sales, which represented approximately 39.6% of all sold devices versus 15.8% in the year-ago quarter.

The reported quarter’s retail service ARPU (average revenue per user) was $55.69 compared with $52.71 in the year-ago quarter. Post-paid churn improved to 1.38% from 1.43% in the year-ago quarter.

Subscriber Statistics

Subscriber gain remained elusive for U.S. Cellular even during the second quarter of the year. The company registered a net loss of 70,000 retail customers versus 3,000 net loss in the year-ago quarter, with the total subscriber base touching 5.97 million.

The company exited the quarter with a retail customer base of 5.64 million compared to 5.78 million in year-ago quarter. There were approximately 2.3 million customers under its Belief plans.

Liquidity

U.S. Cellular generated $221.6 million in cash flow from operating activities in second quarter 2011 compared with $251.5 million in the year-ago quarter and spent $162.1 million in capital expenditures as against $133.5 million in the comparable quarter. This resulted in free cash flow of $59.5 million versus $118 million in the year-ago quarter.

The company exited the second quarter with $428.6 million in cash and cash equivalents, compared with $232.9 million in the year-ago quarter.

Guidance

For fiscal 2011, U.S. Cellular maintained Service revenue estimate in the range of $4,000–$4,100 million and raised its operating income estimate from the range of $185–$285 million to $210–$285 million. The company’s capital expenditures projection remained unchanged at $750–$800 million.

Our Analysis

Despite a challenging subscriber market, U.S. Cellular remains on the growth trajectory through strong smartphone sales. As a result, the company’s data revenues registered an upsurge that improved margin and largely compensated for subscriber loss.

The company remains focused on advertising and marketing strategies to improve customer retention and gain traction in the target market. We believe the continued success of Belief Plans coupled with high-end smartphones and the upcoming launch of 4G wireless services bode well for U.S. Cellular in 2011 and beyond.

However, the company’s increased exposure to strong competitive pricing pressure from telecom giants like AT&T (T - Analyst Report) and Verizon Communications (VZ - Analyst Report) is creating a significant dent in its customer base and leading to loss of market share.

Consequently, we recommend a long-term Underperform rating on U.S. Cellular. However, the company holds a short-term (1–3 months) Zacks #3  Rank (Hold).

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